Japan: All on board for a new growth

Remarks by Angel Gurría, OECD Secretary-General, delivered for the launch of the

Tokyo, Tuesday 23 April 2013

(As prepared for delivery)

Ladies and gentlemen,

I am very happy to be back in Japan. This is indeed an exciting time. There is a feeling of optimism and dynamism in the air and this is reflected in recent economic indicators. Confidence is coming back, both in firms and households.

This comes after a very difficult five years, with two major shocks -- the global financial crisis and the 2011 Great East Japan Earthquake, which the Japanese people confronted with great courage. Indeed, Japan now appears poised for economic expansion. We project real GDP growth of about 1½ per cent in both 2013 and 2014, on a calendar year basis. The expansion will be driven in part by exports, which will in turn boost business investment and employment, thus sustaining private consumption. This expansion is expected to bring an end to 15 years of flirting with deflation.

Abenomics has changed the mood in Japan.

Prime Minister Abe deserves much credit for this new spirit of optimism in Japan, an optimism based on the "three arrows" that he is launching to revitalise Japan and exit deflation. As we know from the 16th century samurai, one arrow can be easily broken. But three arrows will reinforce each other and resist any attempt to break them. Our Survey focuses on these three arrows.

The first arrow is bold monetary policy. The new Bank of Japan governor, Mr. Kuroda, has launched a new monetary policy framework – "quantitative and qualitative monetary easing" – summarised by the number "2". The central bank aims to achieve the 2% inflation target in about two years. And it will do so by doubling the monetary base and its holdings of Japanese government bonds. This new framework is accompanied by a depreciation of the yen, although Japan is not targeting the exchange rate. Bringing a definitive end to deflation is a top priority. And rightly so; deflation has slowed economic growth and exacerbated the fiscal problem over the past 15 years.

The second arrow is a flexible fiscal policy, with a new fiscal package amounting to 2% of GDP. The third one is a new growth strategy, promised by mid-2013. We are anxiously awaiting this strategy and would like to support Japan in its development. A bold strategy to address supply side bottlenecks and increasing the productivity and competitiveness of the Japanese economy is imperative to achieve long-term sustainable growth. The OECD has launched a program for competitiveness of its major member countries, and therefore we applaud this initiative. We also welcome Japan's decision to participate in discussions on the Trans-Pacific Partnership.

Addressing Japan's fiscal situation

While recent developments are encouraging, we cannot overlook the elephant in the room: the extremely high and rising level of government debt. Gross public debt reached 220% of GDP in 2012, the highest level ever recorded in the OECD area. With a large budget deficit of 10% of GDP, this debt ratio will continue rising further into uncharted territory.

The medium-term fiscal plan, promised by the government later this year, should include spending cuts and tax increases large enough to achieve a budget surplus by 2020, thus stabilising the public debt ratio. A detailed and credible package is essential to maintain market confidence, thereby mitigating the risk of a run-up in long-term interest rates.

To achieve these ambitious objectives, it is first necessary to implement the planned hike in the consumption tax from 5% to 8% in 2014 and to 10% in 2015, preferably while maintaining a uniform rate. It is also crucial to control the growth of spending. During the past twenty years, public social spending in Japan has doubled from 11% of GDP to 22%, driven by rapid population ageing. Japan now has the oldest population in the OECD area, and is projected to remain the oldest by 2050. This implies continued upward pressure on spending. Reforms are thus crucial to increase effectiveness of government services, such as in the health sector.

But Japan will also need additional tax revenue. Even with the hike in the consumption tax to 10%, the rate remains about one-half of the average in OECD countries. Additional revenue could thus come from further hikes in the consumption tax rate, given its relatively small negative impact on economic growth. Japan could also, broaden its income tax basis, primarily by increasing environmental taxes.

However, we need to keep in mind the impact of fiscal consolidation on social cohesion. Income inequality and relative poverty have risen in Japan during the past few decades, as in most OECD countries. The level of poverty is now the sixth highest in the OECD. To face this challenge, Japan needs to improve the effectiveness of social welfare programmes. It could do so in part by introducing an earned income tax credit. This would be effective in promoting work and assisting low-income persons, and would also mitigate the regressive impact of the consumption tax hike.

To promote social cohesion, it is also important to attack the root causes of inequality, such as labour market dualism. Non-regular workers are indeed paid only about 60% as much per hour as regular workers. Breaking down this dualism is thus essential. Upgrading training programmes and increasing the social insurance coverage of non-regular workers are two measures, among others, to address this.

Boosting competitiveness through structural and regulatory reforms

The recent positive trends primarily reflect monetary and fiscal stimulus. However, their impact will quickly fade unless they are reinforced by structural reforms to boost Japan's growth potential. Reforms are needed in a wide range of areas, including education and health care, which we discussed in previous OECD Economic Surveys of Japan. This new Survey focuses on two other key areas for reform; agriculture and energy.

Agriculture has long been a declining sector in Japan, and is now dominated by part-time farmers working on small plots of land. The average farm is only two hectares, compared to 14 in the European Union. Meanwhile, the average age of farmers has risen to 66, with 56% of rice farmers over the age of 70. Moreover, prices are high due to extensive government support and import barriers. As a result, consumer spending on agricultural goods is nearly two times higher than what it would be in the absence of government policies.

If nothing is done, the agricultural sector might wither away. It is clear, though, that Japan can develop a competitive agricultural sector. The vegetable industry, for example, has blossomed without being heavily subsidized and sheltered and it now accounts for a larger share of agricultural output than rice. Japan needs not only to promote the consolidation of farmland, but more critically to phase out supply control measures and shift to less distorting kinds of government support. A more market-oriented agricultural sector would facilitate Japan's participation in international trade agreements, such as the Trans-Pacific Partnership. This would in turn help boost Japan’s growth potential.

The Fukushima nuclear accident has also opened the door to a new energy policy, with two priorities. First, increasing renewable energies in the energy mix. At present, renewables play a relatively small role in Japan, accounting for about 11% of electricity generation, half of the OECD average.

Developing renewables will promote green growth, while helping Japan achieve its target of reducing its greenhouse gas emissions. This would require a price on carbon, through a carbon tax in combination with an emissions trading system.

The Fukushima accident also showed the need for a restructuring of the electricity sector, breaking down its current structure dominated by vertically-integrated regional monopolies. The recent Cabinet decision to move ahead with electricity reforms is an important step. It entails the unbundling of generation and transmission and the expansion of competition in the retail market, which we both strongly welcome.

Let me insist now on one last but critical success factor, Japan’s great human resources. Japan needs to make the most of it to face its competitiveness challenge. Your working-age population is projected to fall by 40% by 2050. You need all on board, including women, older persons and youth. This requires profound changes in the society, but also deep reforms in the tax and social systems, education, and in companies’ working practices. Giving women a better start in the jobs markets and improving their participation and contributions is a must.

Ladies and gentlemen,

Next year, 2014, will mark the 50th anniversary of Japan's entry into the OECD. During these fifty years, the OECD has been privileged to work closely with Japan in promoting a "stronger, cleaner and fairer economy". Japan has indeed made major contributions to the Organisation, in critical areas such as innovation, green growth, risk management, among others. These contributions have benefited other member countries and the world economy.

We look forward to continuing to work with Japan as it embarks on a new growth path, led by Prime Minister Abe's three arrows. We have the utmost confidence in Japan's ability to achieve its objectives and overcome the challenges it faces. We are ready and eager to assist Japan to achieve its goals. Thank you!